|a. You expect an RFR of 10 percent and the market return (RM) of 14 percent. Compute the expected return for the following stocks, and plot them on an SML graph.|
|b. You ask a stockbroker what the firm's research department expects for these three stocks. The broker responds with the following information:|
|Stock||Current Price||Expected Price||Expected Dividend|
|Plot your estimated returns on the graph from part (a) and indicate what actions you would take with regard to these stocks. Explain your decisions.|
RFR = 10%
The market return, RM = 14%
The expected return for a stock using CAPM equation is: E (Ri) = RFR + Beta x (RM - RFR)
Please see the table below for E(Ri) of three stocks:
E(Ri) = RFR + Beta x (RM - RFR)
Plot on the SML is shown in the drawing on the white board.
Expected return as per research house = (Expected price + Expected dividend - Current price) / Current Price
Please see the table below:
Expected return as per research house
E (Ri) as calculated in part (a)
ER = (EP + ED - CP) / CP
The plot is shown on the white board. U* represents the expected return as per the research house for stock U and so on.......
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